Value style of investing and Growth style of investing are two approaches we often hear in investment circles. The arguments supporting and opposing value and growth style of investing create confusion in minds of many investors.
Let us understand what Growth style and Value style means.
Growth stocks represent companies that have demonstrated better-than-average gains in earnings in recent years and that are expected to continue delivering high levels of profit growth, although there are no guarantees.
Value stock represents companies that have fallen out of favor but still have good fundamentals. The value group may also include stocks of new companies that have yet to be recognized by investors.
As an investor let us consider two scenarios:
Scenario 1 – Company “A” is operating in Industry which is currently having good tail winds and strong demand outlook. Policies are supporting growth in that industries. As a result, the Industry can grow at a faster pace compared to GDP growth rate. In that, “Company A” is having strong “Moat” and is consistently delivering higher growth than its peers.
Companies which are in above scenario generally trade at higher valuation multiples. Generally, Growth companies are having higher P/E and P/B ratios. So, hypothetically, “Company A” intrinsic value is Rs. 100, and company A is delivering 40% growth, investors are willing to pay Rs. 105 or Rs.110 as they believe that growth will continue and hence the intrinsic value will increase from Rs.100 to Rs. 140.
Scenario 2 – Company “B” is operating in Industry which is currently having head winds and weak demand outlook. Environment is not supportive for growth in that industries. As a result, the Industry is growing at a slower pace compared to GDP growth rate. Although, environment is challenging “Company B” is having strong fundamental business franchise and is able to survive in this.
Companies which are in above scenario generally trade at lower valuation multiples. Generally, value companies are having lower P/E and P/B ratios. So, hypothetically, “Company B” intrinsic value (as perceived as analyst/investor) is Rs. 100, and company A is delivering 10% growth, investors are willing to pay Rs. 70 or Rs.80 as they believe that this situation will change as economic and market cycle play out. As a result, company which is currently trading below its intrinsic value will catch up so, in our example stock price will move from Rs. 80 to Rs. 110.
Now, if you observe, thought process involved is different for both the scenarios. For “Company A” bet that company will continue to grow at higher rate is the main part, where as for “Company B” the change in environment in which the company operates is the catalyst.
Growth or value… or both?
Which strategy — growth or value — is likely to produce higher returns over the long term? The battle between growth and value investing has been going on for years, with each side offering statistics to support its arguments. One important point is that both styles will have periods where they underperform and periods where they will outperform. In different cycles different sectors and different stocks will appear either “Value” or “Growth” so it is important What style you are comfortable following and continue following the same.
History shows us that:
Growth stocks, in general, have the potential to perform better when interest rates are falling, and company earnings are rising. However, they may also be the first to be punished when the economy is cooling.
Value stocks, often stocks of cyclical industries, may do well early in an economic recovery but are typically more likely to lag in a sustained bull market.
When investing long term, some individuals combine growth and value stocks or funds for the potential of high returns with less risk. This approach allows investors to, in theory, gain throughout economic cycles in which the general market situations favor either the growth or value investment style, smoothing any returns over time.